KE Sukuk – spread justifiable?

Be it Shariah compliant or not, the rate of return matters! Yet, investors are seen willing to compromise on the returns on the Islamic side but this applies more to the instruments carrying sovereign ratings such as Ijara Sukuks. That said the upcoming KE Sukuk so far seems to be getting a mixed response from the investors’ community with the premium on offer being the primary consideration.
KE is issuing a rated, listed and secured Sukuk amounting to Rs22 billion, carrying an instrument rating of AA+ by JCR-VIS Credit Rating Agency Limited and Islamic International Rating Agency, Bahrain (IIRA). This marks the company’s second listed Sukuk issue for retail investors. The issue represents a sizable 37 percent of KE’s existing non-current debt and 10 percent of its total liabilities.
Of this aggregate issue amount, pre-IPO placement represents Rs15 billion or 68 percent of the issue, while the remaining Rs7 billion (including green-shoe option of Rs2 billion) will be offered to the general public via an initial public offering (IPO) on Karachi Stock Exchange. Placement by private institutions has been already subscribed and disbursed by the investors and the clientele comprises of banks and mutual funds. However, it is interesting to note that HBL – the country’s largest bank - represents a hefty 30 percent of the entire private placement.
While carrying duration of seven years, the instrument is offering a floating rate of return of 3M KIBOR+1 percent. Based on current KIBOR rates, the return on offer comes around 8.08 percent, thereby being lower than a PIB of similar tenor. As of yesterday, the PKRV rate on a 7 year PIB stood at 8.68 percent.
Besides, market participants opine that a premium of 100bps over KIBOR seems less justifiable in the case of a company like KE. “There is no denying that KE has turned into profits, but it still lacks an extensive profitable track record. Over the years, we have learnt a critical lesson which goes: credit risk is more significant than the market risk.
And given this consideration, a premium in the range of 200-300bps would have furthered the case for this company”, stressed a senior fixed income specialist in a conversation with BR Research.
Although the market has welcomed similar premium levels on long-term Sukuks in yesteryears, but it’s the credit risk of the company that dictates the premium an investor would be willing to greet, a credible fund manager told BR Research. “Recall that WAPDA Sukuk also offered a premium of 100bps over the benchmark on its long-term issue. But KE cannot be considered equivalent to WAPDA”, he added further.
Nonetheless, given that interest rates are on a declining trend, a floating rate of return makes more investment sense for investors and hence the issue seems to have been well-timed in the current scenario.
No wonder the company has revamped itself in recent times and the turnaround of its losses into profits in FY12 bears a strong manifestation to that. Narrowing of line losses and electricity theft has fared well for the company in terms of upturn in collections and shrinking of transmission and distribution (T&D) losses. And not to disregard the marked improvement in its net margins, that has sky-rocketed from 1.61 percent in FY12 to 13.17 percent in 1HFY14. Moreover, the company has added 1,037MW to the system over the last six years, thereby taking the tally to 2,247MW.
But, with the termination of Power Purchase Agreement with NTDC for 650MW earlier this year, the unavailability of power can possibly thwart KE’s fate. But as for now, power supply is being provided from NTDC while the company’s management is in talks with the Ministry of Water and Power for renewal of the said agreement.
Be that as it may, the issue might be gather interest considering the dearth of investment avenues on the Islamic side. It is pertinent to note that KE carries a proven track record of timely payments on its previous TFC and Sukuk issuances, thereby easing investors’ concerns of any default.
Recall that KE’s precious Sukuk issue was well-received by the investors. Perhaps, two key reasons can justify the overwhelming response witnessed in its previous issue: 1) choice of tenors (13 months, 3 years and 5 years) and 2) higher premium levels that ranged between 100bps to 275bps.
Given the above considerations, it will be interesting to see if KE is able to please the crowd with its upcoming Sukuk issue.